MPC may favour status quo on policy rates
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The upcoming RBI’s Monetary Policy Committee (MPC) meeting will be held under the backdrop of sharply falling inflation, while the economic growth trajectory has been clouded by US trade policy. Does that mean RBI’s MPC should cut rates further in the upcoming meeting? We don’t think so.
The RBI had already front loaded the rate cut by 50 bps in the June policy, factoring in a moderation in inflation. Even while the fall in inflation has turned out sharper than anticipated, we feel that the central bank will adopt a wait and watch policy. Given that the RBI had changed the stance to neutral from accommodative, the bar for further rate cut has been raised higher.
CPI inflation fell to around 2 per cent in June and is estimated to remain benign in the next two quarters averaging around 2.5 per cent. The fall in headline inflation has been mainly because of fall in food prices compared to last year. Vegetable inflation that was very high in 2024 averaging 27 per cent, has recorded sharp deflation, averaging -15 per cent in last three months.
Many other components of food basket are also seeing low inflation or deflation supported by good monsoon and high base of last year. The point to note is that a large part of the fall in inflation is because of statistical base effect. Good monsoon will further support food prices in the coming months and overall commodity prices are expected to remain comfortable. However, next year, we will see inflation again rising as the base effect reverses. We expect CPI inflation to breach 4 per cent level in Q4 FY26 and average around 4.5 per cent, with an upward bias in FY27.
Tariff uncertainty
India’s growth outlook has been clouded by the US trade policy uncertainties. The recent reciprocal tariff of 25 per cent (with penalty for trade with Russia) imposed by the US is higher than that imposed on some of the competing countries like Vietnam (20 per cent tariff) and Indonesia (19 per cent), putting India in a disadvantageous position. However, India is a domestic demand driven economy, with trade exposure at a much lower level compared to some of the Asian peers. India’s merchandise exports to US accounts for only around 2 per cent of GDP. We estimate the adverse impact of tariff at 0.3-0.4 per cent of GDP, through the export channel.
However, there is still lack of clarity and it is quite possible that India manages to negotiate a trade deal with the US leading to lower tariff barriers. The RBI may decide to wait and get further clarity on this front to assess the impact on growth. Moreover, there are supportive factors for growth like good monsoon, falling inflation, lower interest rates and lower income tax burden this year.
In this uncertain environment, the central bank may decide to maintain status quo. Additionally, transmission of the cumulative rate cut of 100 bps in this cycle is still underway and could take some more time to show its effect on the economy. The RBI has been maintaining ample liquidity in the system to facilitate transmission of policy rate cuts. Moreover, a hawkish stance from the US Federal Reserve and recent appreciation of the US dollar index could provide further reasons for adopting a wait-and-watch approach, to avoid additional weakening pressure on the rupee.
The RBI had already frontloaded the rate cuts, anticipating moderation in inflation. Hence, we do not expect further rate cuts unless growth concerns aggravate. With a forward-looking outlook, the RBI would be focusing on inflation in the quarters ahead. With CPI inflation estimated to breach 4 per cent in Q4 FY26 and average around 4.5 per cent in FY27, we are looking at real rate of interest of 1-1.5 per cent or even lower next year. With a real rate likely to be at such low levels in 2026, there is no need for further rate cuts.
The writer is Chief Economist, CARE Edge Ratings
Published on August 5, 2025
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